Size matters?

Pfizer’s $160bn deal to acquire Allergan will challenge the new company to show that big is better

After a spate of deals around the turn of the millennium that produced the likes of GlaxoSmithKline, Novartis, Sanofi and Pfizer's $60bn combination with Pharmacia in 2003, the concept of the mega-merger seemed to have fallen into disuse.

Pfizer's next mammoth deal, acquiring Wyeth for $68bn in 2009, briefly revived it, but the joke about a 'PfizerKline' or some such union being next in line never actually played out. But as last year's abortive Pfizer-AstraZeneca and AbbVie-Shire deals showed, the desire for such transactions was returning.

Enter Pfizer, Allergan and a $160bn deal to will create the world's largest pharma company. As Pfizer chief executive Ian Read told investors a month or so before the deal was announced: “This management team is not afraid of taking bold steps.”

Location, location, locationRead will be chairman and CEO of the combined company, while Allergan CEO Brent Saunders will become president and chief operating officer.

Buying Allergan certainly gives Pfizer a leg-up in the specialty drugs business, which has been enjoying buoyant growth despite facing some headwinds at the moment as debate on the pricing of medicines gathers pace. There are also products in CNS and ophthalmology that Pfizer is attracted to.

There is also Allergan's traditional strength in aesthetics, most notably Botox (a pharma product whose place in the popular imagination is perhaps the closest to Pfizer's own Viagra), though it's not just a fix for frown lines. Clinical trials are ongoing to test its application against overactive bladder and migraine. The deal will certainly allow Allergan's products to be sold in more markets than it can currently reach.

But, as was the case with its pursuit of AstraZeneca and AbbVie's planned deal with Shire, location is key. Allergan is domiciled in Ireland and under the terms of their agreement, Pfizer and Allergan will be combined as 'Allergan' - then renamed 'Pfizer' - with Ireland as the new entity's legal domicile. Pfizer's current headquarters in New York will remain the company's operational hub, but its 'principal executive offices' will shift across the Atlantic to Dublin. The move will give Pfizer an opportunity to reduce its corporate tax burden, which was one of the reasons given for its failed pursuit of a merger with AstraZeneca (AZ) last year. In fact its tax rate is expected to drop from around 25% to 17-18%.

[We] are moving forward with our strategy to combine these two great companies for the benefit of patients and to bring value to shareholders. That is our obligation

Show me the moneyThe merger will create a company with $60bn in annual revenues, $2bn in cost savings in the first three years and more than 100 mid- to late-stage R&D programmes in the pipeline, but these have been overshadowed by the debate about Pfizer's tax arrangements. The deal is set to be the biggest case of a 'tax-inversion' deal involving a US corporation. Tax inversion deals involve a corporation re-incorporating overseas in order to shift financial accounting from a high- to low-tax jurisdiction.

The Pfizer/Allergan deal comes despite a pledge from the US Treasury to clamp down on the practice, suggesting federal powers to curtail the activity are limited, and could spark another wave of inversion transactions.

Pfizer chief executive Ian Read said the merger would provide “greater financial flexibility” and also give the group “a more competitive footing within our industry”.

Nevertheless the scale of cost-savings from the deal is expected to be a relatively conservative $2bn, which Pfizer's leadership ascribes to the way both businesses are already very well run, with little overlap between them.

There are signs we may not see the usual 'rationalisation' or 'restructuring' or whatever the euphemism of the moment is for swingeing job cuts - though there's no certainty in such thinking. There's little overlap between the two firms and both chief executives are keenly aware of their new company's need to hold on to its best and brightest.

For its part Allergan says its eye care franchise will stay put in California. The same is likely for its discovery unit and medical aesthetics business in that state. “It's not about protecting people, it's about keeping the best people in the right location to drive value in the future and that will be the philosophy we approach integration with here as well,” Brent Saunders told analysts recently. Ian Read added: “We are very focused on [preserving talent]. I don't think there should be any concerns within either organisations about the fact that we [will] conserve all of the talent expertise that both companies have accumulated to drive our businesses forward.”

Playing politicsTo accuse politicians is probably to miss the point of what their day jobs generally entail. That said, with the November 2016 US presidential elections looming, bluster should be expected and US lawmakers were quick to react to the deal's announcement. All three Democratic presidential candidate nominees - Hillary Clinton, Bernie Sanders and Martin O'Malley - and Republican nominee Donald Trump - issued statements to condemn the move.

Clinton insisted that the merger will leave “US taxpayers holding the bag” and called for urgent action in Congress to crack down on tax inversion deals that that “erode our tax base”, while Trump said: “The fact that Pfizer is leaving our country with a tremendous loss of jobs is disgusting.”

Meanwhile, Sanders tweeted that the deal “would be a disaster for Americans who already pay the highest prescription drug prices in the world”, while O'Malley wrote: “As POTUS I will fight mergers that offshore taxes and jobs, while aggressively enforcing our antitrust laws.”

Read - who wrote to senior politicians before announcing the deal - insists that the merger will allow Pfizer to continue to invest strongly in the US, with the combined company expected to generate annual operating cash flow in excess of $25bn beginning in 2018. But the idea that the merger will benefit the US will be a tough sell.

Speaking to analysts he said: “Recently, there has been much written and said about tax reform from members of Congress to presidential candidates to the recent notice from Treasury. We appreciate that the issues raised are important for the future competitiveness of the country and that many good minds are working to reform the system.

“While reform progresses, we have assessed the legal, regulatory, and political landscape and are moving forward with our strategy to combine these two great companies for the benefit of patients and to bring value to shareholders. That is our obligation.”

It's about keeping the best people in the right location to drive value

Counting down to the new PfizerWhen, as Pfizer and Allergan have done, you host information about your merger on PremierBiopharmaLeader.com there's little doubt about the scale of your ambitions. So, what's next for the new Pfizer?

In a short company video where Read explains that the deal is about: “Two great companies with deep roots in the United States. It will allow these companies to invest more in the United States … it brings together two really strong cultures”. Whether you're more convinced than the US presidential hopefuls on that first point, the second one about culture will be a massive challenge for Pfizer, particularly if the Allergan culture is as strong as its own (see page 19 for more on this). But, cutting to the chase, he adds: “It also offers us the opportunity to use our capital more globally through this transaction.”

But before the dust settles on this deal observers might be wondering whether they should let the dust settle first on Allergan's earlier - and substantial - major M&A transactions. It merged with Actavis in March in a $70.5bn deal and then reached an agreement to sell its generics business to Teva for $40.5bn The Teva deal, due to be completed in the first quarter of next year forms a key consideration for the deal to close. It could, of course, still fall apart. But with termination fees of up to $3.5bn for either side, and then only in certain circumstances, the boards of each side will be concentrating on making this work.

Looking to the longer term, Pfizer has already tentatively started talking about a loose timetable for its long-discussed plans to separate its innovative and established medicine businesses. The plans, first mooted by Read in 2011, will now be shelved while the integration of the two companies takes place, with a decision made on them after 2018. In fact, Read says that the Allergan deal will enable the established products business to be successful, though the detail at this stage is a little light.

So, how many more mergers on this scale we'll see remains to be seen, as does the true political fallout from tax inversion on such a grand scale. But, for Pfizer and Allergan at least, it's clear that size matters. For the rest of us we'll have to wait, at least until some time in the second half of 2016, when the deal is due to be completed, to more fully appraise the new Pfizer and its performance.